2) The Glass-Steagall Act of 1933:
A) separated commercial banking activities from investment banking activities.
B) created the Federal Reserve System.
C) developed the system of commercial bank deposit insurance.
D) all of the above

3) Which of the following is NOT another term for a prime mortgage loan?
A) conventional loan
B) top-qual loan
C) conforming loan
D) All of the above are suitable terms for a prime mortgage loan.

6) A ________ is a financial intermediation device that allowed the participant to borrow short and lend long.
A) sub-prime loan
B) structured investment vehicle
C) non-conforming loan
D) all of the above

8) Which of the following statements concerning credit default swaps is FALSE?
A) As of year-end 2008, CDSs are completely outside of regulatory boundaries.
B) A CDS is a derivative security that may be used for hedging risk or for speculative purposes.
C) In order be a party to a CDO, at least one of either the buyer or seller must own the underlying asset.
D) CDSs allow banks to severe their links to their borrowers, thereby reducing their incentive to screen and monitor the ability of borrowers to repay.

1) Mortgage loans in the U.S. are classified by risk into one of three types: prime, alt-A, and sub-prime.

2) Alt-A mortgage loans are NOT eligible for sale to GSEs such as Fannie Mae or Freddie Mac.

3) The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 explicitly allowed corporate combinations of commercial banks with other types of financial institutions such as insurance companies and investment banking firms.

4) Subprime mortgages did not exceed 8% of all outstanding mortgage obligations by 2007, but by the end of 2008 they were the source of 65% of bankruptcy filings by homeowners in the United States.

5) Even though household debt as a percentage of disposable income rose rapidly in the United States in early 2000s, the rate was even greater in Britain, topping out at over 170% in 2008.

6) From 1990 through 2007, the amount of securitized loans outstanding dropped from over $25 trillion to less than $5 trillion and was a key element in the loss of market liquidity.

7) It is pretty clear after reading this chapter that securitization in and of itself is a poor financial idea.

8) Securitization may degrade credit quality because the process severs the link of lending and repayment (risk and reward) between the originator of the loan and the borrower.

9) The authors make it clear that the main source of market failure with collateralized debt obligations lay almost exclusively with the rating agencies.

10) Credit Default Swaps are highly regulated financial instruments as a result of the Commodity Futures Modernization Act of 2000.

Essay/Short Answer

1) What is a Collateralized Debt Obligation (CDO)? In your answer explain how CDOs are generally separated into one of three tranches. What types of mistakes were made by security rating agencies that contributed to the collapse of the CDO market?

5.2 Global Contagion

Multiple Choice

1) Which of the following is NOT identified by the authors as a “safe-haven” currency?
A) the euro
B) the British pound
C) the U.S. dollar
D) the Japanese yen

5) The British Bankers Association (BBA) estimates that LIBOR was used in the pricing of more than ________ in assets globally.
A) $100 billion
B) $360 billion
C) $360 trillion
D) $100 trillion

6) Which of the following pieces of U.S. legislation was developed and passed in response to the 2008-2009 international credit crisis?
A) Gramm-Leach-Bliley Financial Services Modernization Act
B) Dodd-Frank Wall Street Reform and Consumer Protection Act
C) Depository Institutions Deregulation and Monetary Control Act
D) The Glass-Steagall Act

True/False

1) Bear-Stearns is the largest single bankruptcy in U.S. history.

2) The international credit crisis began in full force in September 2008.

3) Near the end of the U.S. housing boom, many of the mortgages classified as Alt-A were in fact sub-prime.

4) LIBOR stand for the London Interbank Offered Rate.

5) The credit crisis was worsened by the destabilizing effects of speculators, in a variety of different institutions, betting that particular instruments or markets or securities would fail.

Essay/Short Answer

1) What is TARP? Provide an argument for why TARP was necessary and successful.

2) Future financial market regulation must include all of the following EXCEPT:
A) renewed regulatory requirements.
B) increased reporting.
C) greater transparency in pricing and valuation.
D) Regulation must include all of the above.

3) In finance, a liquid asset:
A) sells quickly.
B) sells at or near its market value.
C) both A and B
D) none of the above

4) Debt issued by the national government is called:
A) debenture debt.
B) municipal debt.
C) sovereign debt.
D) none of the above

5) The member nations of the European Union have relative freedom to set their own fiscal policies EXCEPT for which of the following?
A) government spending
B) government taxation
C) government surpluses or deficits
D) government printing of the euro currency

6) When the EU moved to a single currency with the adoption of the euro, its member states agreed to each of the following EXCEPT:
A) a single currency.
B) control of their own money supply.
C) free movement of capital in and out of their economies.
D) In fact, the member states agreed to ALL of the above.

7) As of 2011, the European countries with the highest debt/GDP ratio were, in order:
A) Greece, Italy, Portugal, and Slovenia.
B) Greece, Italy, France, and Germany.
C) Greece, Italy, Ireland, and Portugal.
D) Greece, Italy, Great Britain, and Portugal.

8) In October 2009, the new government of Greece estimated the size of the 2009 government budget deficit as 12.7% of GDP rather than the previously published:
A) 3.4%.
B) 6.7%.
C) 8.6%.
D) 10.2%.

True/False

1) The authors conclude the chapter with a specific road map for future financial regulation.

2) Baring the (hopefully temporary setback of 2008) capital is more mobile today than ever before.

3) Securitization is likely to be declared illegal in the U.S. though it may still exist elsewhere in the world.

4) Every EU member nation has the right to simply print more euros.

5) The members of the EU’s eurozone (euro participants) do NOT have the ability to conduct independent monetary policy.

6) The European Financial Stability Facility (EFSF) has a mandate to safeguard financial stability in Europe by providing financial assistance to euro area Member States.

7) Ireland and Greece had the same issues lead to their financial crises in 2009. In each case, the previous government had dramatically understated the size of their federal budget deficit as a percentage of GDP.

Chapter 6 The Foreign Exchange Theory and Markets

6.1 Geographical Extent of the Foreign Exchange Market

Multiple Choice

1) Which of the following is NOT true regarding the market for foreign exchange?
A) The market provides the physical and institutional structure through which the money of one country is exchanged for another.
B) The rate of exchange is determined in the market.
C) Foreign exchange transactions are physically completed in the foreign exchange market.
D) All of the above are true.

2) A/An ________ is an agreement between a buyer and seller that a fixed amount of one currency will be delivered at a specified rate for some other currency.
A) Eurodollar transaction
B) import/export exchange
C) foreign exchange transaction
D) interbank market transaction

3) While trading in foreign exchange takes place worldwide, the major currency trading centers are located in:
A) London, New York, and Tokyo.
B) New York, Zurich, and Bahrain.
C) Paris, Frankfurt, and London.
D) Los Angeles, New York, and London.

True/False

1) Because the market for foreign exchange is worldwide, the volume of foreign exchange currency transactions is level throughout the 24-hour day.

2) Business firms in countries with exchange controls, for example, China (mainland), often must surrender foreign exchange earned from exports to the central bank at the daily fixing price.

Essay

1) Define spot, forward, and swap transactions in the foreign exchange market and give an example of how each could be used.

6.2 Functions of the Foreign Exchange Market

Multiple Choice

1) The ________ is the mechanism by which participants transfer purchasing power between countries, obtain or provide credit for international trade transactions, and minimize exposure to the risks of exchange rate changes.
A) futures market
B) federal open market
C) foreign exchange market
D) LIBOR

2) Which of the following is NOT a motivation identified by the authors as a function of the foreign exchange market?
A) the transfer of purchasing power between countries
B) obtaining or providing credit for international trade transactions
C) minimizing the risks of exchange rate changes
D) All of the above were identified as functions of the foreign exchange market.

True/False

1) Foreign exchange markets are a relatively recent phenomenon, beginning with the agreement at Bretton Woods.

2) It is characteristic of foreign exchange dealers to:
A) bring buyers and sellers of currencies together but never to buy and hold an inventory of currency for resale.
B) act as market makers, willing to buy and sell the currencies in which they specialize.
C) trade only with clients in the retail market and never operate in the wholesale market for foreign exchange.
D) All of the above are characteristics of foreign exchange dealers.

3) Which of the following may be participants in the foreign exchange markets?
A) bank and nonbank foreign exchange dealers
B) central banks and treasuries
C) speculators and arbitrageurs
D) all of the above

4) ________ seek to profit from trading in the market itself rather than having the foreign exchange transaction being incidental to the execution of a commercial or investment transaction.
A) Speculators and arbitrageurs
B) Foreign exchange brokers
C) Central banks
D) Treasuries

6) Foreign exchange ________ earn a profit by a bid-ask spread on currencies they purchase and sell. Foreign exchange ________, on the other hand, earn a profit by bringing together buyers and sellers of foreign currencies and earning a commission on each sale and purchase.
A) central banks; treasuries
B) dealers; brokers
C) brokers; dealers
D) speculators; arbitrageurs

1) Dealers in foreign exchange departments at large international banks act as market makers and maintain inventories of the securities in which they specialize.

2) Currency trading lacks profitability for large commercial and investment banks but is maintained as a service for corporate and institutional customers.

3) The primary motive of foreign exchange activities by most central banks is profit.

4) Banks, and a few nonbank foreign exchange dealers, operate ONLY in the interbank markets.

5) Dealers in the foreign exchange departments of large international banks often function as “market makers.” Such dealers stand willing at all times to buy and sell those currencies in which they specialize and thus maintain an “inventory” position in those currencies.

6) Currency trading is a service center rather than a profit center for commercial and investment banks.

7) For individuals and firms involved in the import and export of goods and services ,using the foreign exchange market is necessary, but incidental, to their underlying commercial or investment purpose.

Essay/Short Answer

1) What are some of the reasons central banks and treasuries enter the foreign exchange markets, and in what important ways are they different from other foreign exchange participants?

2) The greatest amount of foreign exchange trading takes place in the following three cities:
A) New York, London, and Tokyo.
B) New York, Singapore, and Zurich.
C) London, Frankfurt, and Paris.
D) London, Tokyo, and Zurich.

3) The four currencies that constitute about 80% of all foreign exchange trading are:
A) U.K pound, Chinese yuan, euro, and Japanese yen.
B) U.S. dollar, euro, Chinese yuan, and U.K. pound.
C) U.S. dollar, Japanese yen, euro, and U.K. pound.
D) U.S. dollar, U.K. pound, yen, and Chinese yuan.

4) A ________ transaction in the foreign exchange market requires an almost immediate delivery (typically within two days) of foreign exchange.
A) spot
B) forward
C) futures
D) none of the above

7) A common type of swap transaction in the foreign exchange market is the ________ where the dealer buys the currency in the spot market and sells the same amount back to the same bank in the forward market.
A) “forward against spot”
B) “forspot”
C) “repurchase agreement”
D) “spot against forward”

8) The ________ is a derivative forward contract that was created in the 1990s. It has the same characteristics and documentation requirements as traditional forward contracts except that they are only settled in U.S. dollars and the foreign currency involved in the transaction is not delivered.
A) nondeliverable forward
B) dollar only forward
C) virtual forward
D) internet forward

9) Which of the following is NOT true regarding nondeliverable forward (NDF) contracts?
A) NDFs are used primarily for emerging market currencies.
B) Pricing of NDFs reflects basic interest rate differentials plus an additional premium charged for dollar settlement.
C) NDFs can only be traded by central banks.
D) All of the above are true.

10) A ________ transaction in the interbank market is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.
A) spot
B) forward-forward
C) swap
D) futures

True/False

1) A spot transaction in the interbank market for foreign exchange would typically involve a two-day delay in the actual delivery of the currencies, while such a transaction between a bank and its commercial customer would not necessarily involve a two-day wait.

2) Swap and forward transactions account for an insignificant portion of the foreign exchange market.

3) Nondeliverable Forwards were originally envisioned as a method of currency speculation, but it is now estimated that 70% of NDFs are trading for hedging purposes.

4) In general, NDF markets normally develop for country currencies having large cross-border capital movements, but still subject to convertibility restrictions.

5) NDFs are traded and settled inside the country of the subject currency, and therefore are within the control of the country’s government.

6) A contract to deliver dollars for euros in six months is both “buying euros forward for dollars” and “selling dollars forward for euros.”

2) The greatest volume of daily foreign exchange transactions are:
A) spot transactions.
B) forward transactions.
C) swap transactions.
D) This question is inappropriate because the volume of transactions are approximately equal across the three categories above.

3) The United Kingdom and United States together make up nearly ________ of daily currency trading.
A) 25%
B) 35%
C) 45%
D) 55%

1) As you might expect, the foreign exchange daily trading volume in in New York City is roughly twice as large as the daily trading volume in London.

2) The low level of interest rates around the globe in recent years, combined with slowing economic growth and new debt issuances, has had a dampening impact on the swap market.

3) Since the global financial crisis of 2008-2009, the Chinese renminbi (yuan) has become the most widely traded currency with the U.S. dollar surpassing the euro, yen, and pound as dollar trading pairs.

6.6 Foreign Exchange Rates and Quotations

Multiple Choice

1) A foreign exchange ________ is the price of one currency expressed in terms of another currency. A foreign exchange ________ is a willingness to buy or sell at the announced rate.
A) quote; rate
B) quote; quote
C) rate; quote
D) rate; rate

2) Most foreign exchange transactions are through the U.S. dollar. If the transaction is expressed as the foreign currency per dollar this known as ________ whereas ________ are expressed as dollars per foreign unit.
A) European terms; indirect
B) American terms; direct
C) American terms; European terms
D) European terms; American terms

3) The following is an example of an American term foreign exchange quote:
A) $20/£
B) €0.85/$
C) ¥100/€
D) none of the above

4) American and British meanings differ for the word billion. Therefore, when traders refer to an American billion, they call it a/an:
A) Kiwi.
B) Loony.
C) Uncle Sam.
D) Yard.

5) From the viewpoint of a British investor, which of the following would be a direct quote in the foreign exchange market?
A) SF2.40/£
B) $1.50/£
C) £0.55/€
D) $0.90/€

6) A/an ________ quote in the United States would be foreign units per dollar, while a/an ________ quote would be in dollars per foreign currency unit.
A) direct; direct
B) direct; indirect
C) indirect; indirect
D) indirect; direct

7) If the direct quote for a U.S. investor for British pounds is $1.43/£, then the indirect quote for the U.S. investor would be ________ and the direct quote for the British investor would be ________.
A) £0.699/$; £0.699/$
B) $0.699/£; £0.699/$
C) £1.43/£; £0.699/$
D) £0.699/$; $1.43/£

8) ________ make money on currency exchanges by the difference between the ________ price, or the price they offer to pay, and the ________ price, or the price at which they offer to sell the currency.
A) Dealers; ask; bid
B) Dealers; bid; ask
C) Brokers; ask; bid
D) Brokers; bid; ask

12) Refer to Table 6.1. According to the information provided in the table, the 6-month yen is selling at a forward ________ of approximately ________ per annum. (Use the mid rates to make your calculations.)
A) discount; 2.09%
B) discount; 2.06%
C) premium; 2.09%
D) premium; 2.06%

14) The U.S. dollar suddenly changes in value against the euro moving from an exchange rate of $0.8909/euro to $0.08709/€. Thus, the dollar has ________ by ________.
A) appreciated; 2.30%
B) depreciated; 2.30%
C) appreciated; 2.24%
D) depreciated; 2.24%

15) A German firm is attempting to determine the euro/pound exchange rate and has the following exchange rate information: USD/pound = $1.5509/£ and the USD/euro rate = $1.2194/€. Therefore, the euro/pound rate must be:
A) £1.2719/€.
B) €1.2719/£.
C) €0.7316/£.
D) €0.7863/£.

True/False

1) The European and American terms for foreign currency exchange are square roots of one another.

2) When the cross rate for currencies offered by two banks differs from the exchange rate offered by a third bank, a triangular arbitrage opportunity exists.

3) Most transactions in the interbank foreign exchange trading are primarily conducted via telecommunication techniques and little is conducted face-to-face.

4) A confusing “quirk” of international exchange rates occurs when calculating the percentage change in spot rates from one period to another. The percent change in the spot rate from one period to another when quoted using foreign currency terms is always greater than the percent changes quoted when using home currency terms.